Overview of New Roth IRA
The recently passed SECURE 2.0 Act of 2022 provides a new rule that allows distributions from 529 plans to Roth IRAs effective in 2024. This provision helps alleviate one of the biggest concerns that taxpayers have with funding 529 plans – namely the uncertainty that the beneficiary of the plan will even attend college.
Advantage of the New Rule
Prior to the new rule, if the beneficiary of a 529 plan completed their education without fully depleting the plan account balance, there were limited options for what to do with the remaining funds. Currently, the most common approach is to change the account beneficiary to another member of the family, but other options included withdrawing up to $10,000 to pay toward qualified education loans of the beneficiary or simply withdrawing the funds for nonqualified use. This would result in any allocated earnings of the distribution being included in gross income of the beneficiary and a 10% penalty being applied to those earnings.
With the option to transfer all (or at least a portion) of the remaining funds in a 529 account to a Roth IRA, it appears that Congress would like to incentivize more taxpayers to take advantage of the tax-free growth that 529 plans offer as early as possible.
Limitations of the Rule
There are number of limitations on the new rule, including:
The lifetime maximum a 529 plan beneficiary can transfer to a Roth IRA is $35,000.
The 529 account must have existed for at least 15 years.
No contributions or earnings on contributions from the last five years are eligible to be transferred.
The transfers are subject to annual Roth IRA contribution limits (except there is no upper income limitation).
Please contact your trusted advisor at Reese Henry & Company if you have any questions about this new provision.